Four Reasons to Buy Foreclosures

We are going to give you four reasons to buy foreclosures. One of these reasons by itself is enough to make foreclosures a good investment. When you buy foreclosures, you are buying wholesale real estate, you are buying from a wholesale seller, you have less competition than buying retail property, and you have the opportunity to make Quick Cash.

Reason 1: Buying Wholesale Real Estate

Foreclosures are by definition wholesale real estate. Why would you want to pay retail for anything that you can buy wholesale? Real estate is the same way. When you are buying foreclosures, you are buying real estate at a wholesale price. And since real estate is the highest-priced commodity that people buy, when you buy real estate wholesale, you have an opportunity to make a lot of money.

You might think that foreclosure properties are run down or in poor shape. While this is certainly the case for some of the foreclosure properties that we have been involved with, it is not always so. You might also think foreclosure properties are in bad neighborhoods. Again, while that can be the case, we have found foreclosures in some very nice neighborhoods that were in very good condition.

Real Estate Lenders Ninety-five percent of the foreclosure market begins and ends with real estate lenders. When you understand how lenders operate,you will increase the likelihood of being successful with foreclosure investing. There are two keys: (1) Lenders get the money they make real estate loans with at a wholesale interest rate, and (2) lenders only make wholesale real estate loans (usually no more than an 80 percent loan-to-value).

Lets look at how real estate lenders operate in the real estate market. Real estate lenders make money by loaning money. How lenders get the money to loan is from people like you and us. When people put money in the bank, the bank pays those people interest or rent for their money. When the bank loans money to someone to buy real estate, it loans the money for the real estate loan at a higher interest rate than the bank pays in interest to its customers.

Wholesale Interest You could say that the bank pays a wholesale interest rate to get its money and then receives a retail interest rate when it loans its money. For example, a bank may pay 3 percent interest to its customers for certificates of deposit (CDs). Then the bank turns around and loans the money from the certificates of deposit to real estate borrowers for real estate loans at 7 percent interest.

The bank makes money on the spread between the wholesale interest rate it pays on the CDs and the retail interest rate it charges on the real estate loans.

Rule of 72 This is a good place to teach you the Rule of 72. The Rule of 72 states that whatever annual rate of return you receive on your investment, real estate or otherwise, your investment will double in the number of years you get as the answer to dividing the rate of return into 72.

The Rule of 72 assumes you leave the investment return with the investment each year so you are compounding your investment return. We will assume your investment is in a tax-free or tax-deferred vehicle.

Real estate appreciation works well with the Rule of 72. If your property appreciated 6 percent annually, it would double in value in 12 years (6 goes into 72 12 times).

But back to the real estate lender. If you receive 3 percent annual interest on $200,000 worth of CDs, then, according to the Rule of 72, your $200,000 will become $400,000 in 24 years (3 goes into 72 24 times). If the real estate lender receives 7 percent annual interest on $200,000 worth of real estate loans, then according to the Rule of 72, their $200,000 will become $400,000 in 10 years (7 goes into 72 10 times).

What is truly amazing about these numbers is if we look at them over the course of a 30-year real estate loan. Your $200,000 in CDs will double once to $400,000 in 24 years. Over the next six years (from 24 years to 30 years), your $400,000 will become $500,000.

Certificates of Deposit

$200,000 @ 3% Interest 72 -v- 3 = 24 Years Doubles to $400,000

Real Estate Loans

$200,000 @ 7% Interest 72 - 7 = 10 Years Doubles to $400,000

What do you think will happen to the banks $200,000? The banks $200,000 will double to $400,000 after 10 years, as we have already noted. The $400,000 will double to $800,000 in another 10 years (20 years total).The $800,000 will double to $1,600,000 in another 10 years (30 years total). The lender will have to give $500,000 to you for your $200,000 in CDs plus interest. The lender will make $1,100,000 profit!

Certificates of Deposit Real Estate Loans

$200,000 @ 3% Interest $200,000 @ 7% Interest

In 30 Years In 30 Years

Becomes Becomes

$500,000 $1,600,000

Now you know why real estate lenders want to be in the real estate-lending business. They make so much money on the interest rate spread. Real estate lenders do not want to be in the real estate-owning business.

Wholesale Loans Real estate lenders will only loan 80 percent of the appraised value of the real estate to protect themselves in the event the borrower defaults on their loan payments. In other words, a real estate lender will only make a wholesale real estate loan. The amount the lender loans is called the loan-to-value ratio. How much money would a bank loan on a property that was appraised (valued) for $200,000?

Loan-to-Value Ratio

Appraised Value $200,000

Maximum Loan Percentage X 80% Maximum Loan Amount $160,000

As you can see from these numbers, real estate lenders protect themselves by making sure they have a 20 percent cushion between the appraised value, $200,000, and the loan value, $160,000. This $40,000 cushion is typically the borrowers down payment on the property. Even if the borrower defaults to the tune of $10,000, the lender is protected.

Lender Protection

Appraised Value $200,000

Maximum Loan Amount - $160,000

Default Amount - $ 10,000

Lender Protection $ 30,000

Lender Loss 0